I have written about Price Earnings ratio earlier, but Cash flow ratios are a better measurement of a stock`s value than P/E. When you read about stocks in the media, you only read about a company`s P/E, and never about a company`s cash flow.
Cash flow is the money that is moving (flowing) in and out of your business in a month.
If more money is coming in than is going out, you are in a Positive cash flow situation. Voila, you can pay your bills. If more money is going out than coming in, you are in a danger of being overdrawn.
Company`s in trouble typically need working capital in form of a loan or line of credit to cover shortages in cash flow. Sometimes customers are not paying at the right time of purchase. It may take some time in B2B business, and that can be a problem for some companies.
Knowing the number about a company`s P/E is good, but knowing a company`s cash flow is better. You have probably heard about how much cash Apple Inc have, and how much cash a company can generate tells you about its health.
P/E ratio represents the ratio of the stock`s price to its earnings per share (EPS). It is important to know about a company`s P/E. You can hear about it in the media daily, even if the P/E is high or if the P/E is low.
Many investors seem to overlook the importance of cash flow, and rather only look at the P/E. It is much better and more important to look at a company`s price relative to its cash position. Therefore; look at the cash flow.
It`s simple: without cash, you won`t last long. As a private person, you probably know how that is? We live in a world of capitalism, and what are you gonna do without capital? There is a long list of companies that failed because cash was in too short supply.
But how can you see if a company is over or undervalued, which is the same purpose of P/E? Two measurements shed light on a company`s valuation.
Price to Cash flow
You determine the price to cash flow by dividing the stock`s price by cash flow per share. The use of cash flow instead of net income is the reason why many investors use this measurement. You can find net income in computing EPS.
You will see that the company have more cash than the net income figure indicates, because the expenses don`t involve actual cash.
Free Cash flow
Divide the current price by the free cash flow per share. The result gives you the value the investors places on the campany`s ability to generate cash. It describes how much cash the company generated in the trailing 12 months.
Just like P/E, you can see where the market values the company. Lower numbers relative to its industry and sector suggest the market has undervalued. Higher numbers than the industry and sector suggests the market has overvalued the stock.
It`s easy to find the numbers and don`t worry, because you don`t have to do the math by yourself. You can simply go to a web site with these valuation numbers and look for your company`s cash flow numbers.
You should never use only one measurement, because it`s not as simple as that and it doesn`t tell you the whole story. You must see the bigger picture. Look at other metrics to verify relative value, but cash flow can give you the clues to how other investors values a stock.
Reports today:
08:30 a.m EST PPI m/m
08:30 a.m EST Core PPI m/m
10:30 a.m EST Crude Oil Inventories
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